UK tax environment for UK and international private equity executives

After a landslide Labour victory, expected changes to the UK taxation of non-domiciled individuals, coupled with planned changes to the tax treatment applying to carried interest returns could significantly limit the attractiveness of the United Kingdom as a host to private equity businesses and the growth companies they invest in.

Domicile is a legal concept and is not defined for tax purposes. Broadly speaking, while individuals inherit domicile from their father, domicile is generally the country which they consider to be their permanent home. Non-UK domiciled individuals can choose to be taxed on the ‘remittance basis’, where tax is only paid on any non-UK income and gains to the extent these funds are brought to, received, or used in the UK. This is not possible after the individual has been resident in the UK for 15 of the past 20 tax years.

Carried interest is already subject to a special tax regime, with the initial awards being subject to income tax at the time of granting and resulting gains taxed at a higher rate of tax than other capital gains (28%).

From 8 July 2015, carried interest could no longer be classified as foreign source, but could still be subject to the remittance basis, to the extent that it relates to services not performed in the UK.

In the March 2024 Budget speech, the then Chancellor announced plans to replace the remittance basis regime with one based on tax residence, which were put on hold once a General Election was announced. In opposition, the now Labour Government largely endorsed these plans, which followed its longstanding commitment to abolish non-domiciled status. It would therefore be prudent to assume that the core principles behind the planned changes will form part of legislation to be introduced by our new Government. The eventual rules may even be more stringent.

The new Labour Government stated in its manifesto that it will close the carried interest “loophole”. Details are not yet available, but it is widely expected that this will be done by increasing the rate of tax applying to carried interest gains, and that rate could be aligned with the top rate of income tax (45%).

The FIG regime planned by the last Government would mean that individuals would not pay tax on foreign income and gains for the first four years after becoming UK tax resident, regardless of whether or not the income or gains were brought to the UK.

The regime is aimed at those coming to the UK either for the first time or after an absence of over 10 years, without reference to their domicile status.

The new Government might choose to make changes to the proposed new rules, for example by extending the relevant period for the FIG regime beyond 4 years, and introducing an accompanying charge to access the regime.

Overseas workday relief rules were also due to be revised. Under existing rules, inbound non-UK domiciled employees can benefit from an income tax exemption on income from non-UK duties for the first three years of UK residence, subject to that income not being remitted to the UK. The new rules would have removed the requirement to keep the income offshore, meaning that the overseas element of the employment income could be brought to the UK without a tax charge. It remains to be seen whether the ‘three year’ rule would be extended to four years to complement the FIG regime.

The then Chancellor also announced transitional arrangements would be made available to existing non-UK domiciled individuals after 6 April 2025. These were to include an option to rebase the value of capital assets to their value on 5 April 2019, a temporary 50% exemption on the taxation of foreign income in 2025/26 for those losing access to the remittance basis on 6 April 2025 and a two-year ‘temporary repatriation facility’ allowing individuals to remit pre-6 April 2025 foreign income and gains to the UK at a reduced blanket 12% tax rate.

These could be helpful to executives looking to reduce their tax burden and bring in historically earned funds, but it is far from certain as to the extent to which these transitional measures will now be introduced. In opposition, the new Chancellor implied that the temporary 50% exemption on the taxation of foreign income in 2025/26 would not be introduced.

The combination of the changes to the taxation of non-UK domiciled individuals and an increase in the rate of taxation applying to carried interest could have a significant impact on the net of tax returns that are paid to executives.

For example, under current rules, a non-domiciled individual taxed on the remittance basis, who receives a carried interest award of £10,000 in respect of which 50% of the work is carried out abroad, would suffer a tax liability of £1,400 (28% x 50% x £10,000).

If changes are implemented as discussed above, such an individual would see their tax liabilities increase by more than 200% to £4,500 (45% x 100% x £10,000),

There could however be tax benefits for those only in the UK in the short term, but it remains to be seen how this situation will be addressed under the new rules.

The new FIG regime, as announced, was framed to attract foreign investment by those newly arriving in the UK, although there are advantages and disadvantages for taxpayers when compared to the existing regime.

The new Government needs to be careful not to make the regime so onerous, in terms of both compliance costs and tax burden, that the competitiveness of the United Kingdom, as a home for an industry that contributes significantly to the strength of the UK economy in funding and scaling British businesses and infrastructure investments, is affected.

The narrow view of tax rates must be balanced with a need for the UK tax system to be competitive with other developed economies.  The largest businesses, on which the new Government depends for any hoped-for increase in tax revenue, operate on a global scale.

Senior executives are more mobile and flexible than ever, and if the new Government overreaches, those executives paying the highest rates of tax may choose to relocate to a more favourable jurisdiction prior to the receipt of any returns. The result could be an overall reduction not just in the overall tax take but could also diminish long-term capital funding for UK businesses as well as drain knowledge and expertise from the UK economy.

With the new Government likely to give its first Budget in September, those executives potentially caught in this situation should consider having a conversation about what planning steps might be taken in advance of any changes.

If you have any questions or want to understand how these proposed changes may affect you, please speak to your usual contact or get in touch with the contacts listed.

Approval code: NTEH70624112